6th October 2011
Gilts were always likely to do well given the climate of risk aversion, but Japan? The absolute return sector? Investment grade corporate bonds? Why have these sectors performed better during the downturn and are they still likely to offer protection for investors?
1) Japan – Japan is currently the top performing geographic area over the past three months by around 8%, with the average fund having dropped just 6.7%. Perhaps even more surprising is the outperformance of the Japanese smaller companies sector, which has dropped just 2.2% over the same period.
Its success certainly isn't anything to do with its economic outlook as this Citywire article suggests. Equally, while the sell-off after the earthquake may have flattered figures, the sector is among the top performing equity sectors over one year as well.
Japan has been supported by institutional investors, who accelerated investment after the earthquake. But much of its outperformance was simply because it became too cheap. Schroders' Nathan Gibbs is quoted in this Trustnet piece: "The market is very, very undervalued at the moment. When we are looking at the strength of companies it is hard to understand why they are so cheap. With the global economic environment as it is, they may well get cheaper still, but value must correct itself sooner or later."
Japan has also benefited because relative to its developed market peers, it no longer looks like the only one with a sluggish economy and weak growth. This partly explains the outperformance of more domestically-focused smaller companies.
2) Absolute return sector – Yes, the absolute return sector should, in theory, be able to deliver positive returns in all market environments. But – as this article points out – many of these funds haven't delivered (to the extent that there have been worries over mis-selling).
Yet, during this particular crisis, many absolute return managers have hung on to their shirts: The average fund is down 2.7%, compared to a fall of 17.5% for the average UK All Companies fund. In fact, only three funds out of 60 in the sector have fallen more than 10%.
The sector attracts a lot of debate – this thread on Citywire shows the opposing sides. Chris Marsden says: "It's a worthwhile product, especially for the old dodderers that don't want any excitement (btw, I am retired). I prefer to try for a bit more than the banks wish to pay, but i DO monitor and switch when I feel it is necessary."
But he adds that investors need to be careful on the performance fees charged by absolute return funds: "I hate performance fees. I never thought I would be defending fund managers who charge them, but IF they say what they are, AND they perform well, really well to justify the PF, then it's a free world, let them offer it."
3) Corporate bonds – At the start of this year, many were predicted the end of the long running bull market in higher grade corporate bonds. Jenna Barnard at Henderson outlined the inherent problems in the corporate bond sector back in April here. She said that investment grade corporate bonds have seen a strong run and do not tend to perform at this time in the cycle. The recent sell-off in risk may have given the sector a last gasp but as our Mindful Money article suggests here – high yield bonds seem to have more compelling valuations. The income yields on corporate bonds are still attractive with most funds in the sterling corporate bond sector offering yields of between 4% and 6%. As such, they do not have quite the same risks as developed market government bonds.
There are always some surprising success stories in every market sell-off. These three areas would have been difficult to predict at the start of the year, with the possible exception of Japan, which had strong valuation support. The beauty of diversification is that investors may not know those assets that will protect their portfolios, but they are likely to hold them anyway.
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